How to Avoid the 6 Traits of Forex Market Fools

The Below was sent to me from Jack Crooks of MoneyandMarkets.com I thought it was a good read for forex traders.

Traits we all exhibit at times are what swiftly separates us from our money — traits of an “acute successful randomness fool,” as defined by Nassim Taleb, author of the excellent book, Fooled by Randomness.

Today, I’d like to examine these common traits. Because if you can identify and recognize the traits of fool, and apply some simple principles, you’ll have your own built-in risk management system in place.

Keep in mind, though, that even some of the best traders in the world are prone to these mistakes, as we see so often in the blow up of funds and firms. So if it can happen to the pros, it can happen to you.

After each of the traits of market fools I provide an example that perhaps you can all relate to, and a reality bite to show the proper perspective and simple ways to avoid these mistakes.

Trait #1 — An overestimation of the accuracy of their beliefs in some measure, either economic or statistical

Example: The U.S. dollar MUST fall because the current U.S. account deficit is rising. Reality: No it doesn’t have to fall. If money pours into the United States from international investors for whatever reason (stocks, high yield deposits, real property, etc.) the dollar will rise regardless of what the current account deficit does. Develop reasons, but don’t be dogmatic.

Trait #2 — A tendency to get married to positions

Example: The dollar sold off even though the jobs report said employment is strong. I’m right, the market is wrong. Reality: It’s always about price action. There is much going on in the market, and a lot we will never know about. Price action tells us that our reasons may be wrong, no matter how much evidence we gather. Listen to the market. It’s your only master.

Trait #3 — The tendency to change their story

Example: You are a short-term trader and the market just moved against you on a key daily report. You rationalize that it’s okay, because “I’m in this trade for the long haul, and sooner or later I will be right.” Reality: If you develop reasons and time frames, stick with them. If the market gives you information that says your view is wrong, get out! You can always re-enter. Getting out will at least give you an opportunity to more objectively evaluate new information.

Trait #4 — No precise game plan ahead of time as to what to do in the event of losses

Example: You enter the trade thinking you’re going to make big money — all you think about is your reward. Reality: You should always think of your risk before you enter a position — that’s what professional traders and speculators do. You must consider your risk beforehand because if you wait until you have already taken a position, you tend to lose your objectivity.

Example: You liked owning the euro when it was at $1.40 against the dollar, you will love it at $1.35 — the average down mentality. Reality: This goes to point number 4 above; set your risk parameters ahead of time by establishing a stop-loss level to exit a trade and stick with it — don’t rationalize. The euro at $1.35 may indeed prove to be a bargain. But it may also be the start of a major decline that can significantly damage your capital or wipe you out if you are trading with high leverage.

Trait #6 — Denial
Example: Well, I really got hosed on that trade — it was bad luck. Reality: There is usually a very good reason why you lose money. Take the time to try to understand it. You learn more by objectively analyzing your investment mistakes than you do by studying your winners.

The bottom line of all this is that you can never keep from being fooled by the market. But you can control your risk. And if you can control your risk and stay in the game to fight another day, your chances of winning will increase dramatically.

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